Retail loans are not self-productive but increase the demand for houses, vehicles and consumer goods
The history of retail loans dates back to the Vedic period when merchants worldwide grain loans to farmers and traders who carried goods between cities. During the Maurya dynasty, an instrument called Adesha was used, which was an order on a banker desiring to pay the money of the note to a third person that corresponds to the definition of a bill of exchange.
What are retail loans?
Retail loans are loans provided by banks and financial institutions to consumers for their financial needs such as buying a house, owning a vehicle, paying for a college education, and satisfying one’s personal needs. These loans are not self-productive in nature but increase the demand for houses, vehicles, consumer goods, etc. and thus contribute significantly to the development of the economy. An educational loan will directly affect the Job Sector as it brings better and high-paying jobs to the students taking the same. The amount of educational loans in the US is a staggering $ 1.676 trillion and a falling job sector can have cascading effects on the repayment of these loans thus affecting the economy in a big way.
Why retail loans?
Retail loans like housing are fully secured by the mortgage of the house thus giving comfort to the lending institution of the repayment while other retail loans are generally backed by the salary/business income of the borrower. Thus banks can price these loans at lower rates of interest and since the liability is spread across a number of borrowers the chances of repayment increase as against a loan given to a corporate which could turn bad and the entire loan could be in jeopardy. The risk is spread out in the case of retail loans than a corporate loan.
Different types of loans
The common retail loans are:
1. Housing Loans
2. Educational Loans
3. Vehicle Loans
4. Personal Loans
There can be a few others like gold loans, credit card outstandings, but these are more short-term loans and are to be repaid in a maximum of a month to say one year. The names of each loan indicate the purpose for which they are taken. Personal loans are generally taken for purchasing consumer durables, marriages, emergency purposes, consolidating debts, etc. Personal loans are generally the costliest in terms of ROI amongst the four loans as they are not backed by any primary security.
Watch out before taking loans
Given below are a few important points one must ponder upon before availing of a retail loan:
1. Your total EMI (Equated Monthly Instalments) of all loans put together should not exceed 65 per cent of your total take-home salary.
2. Do not go for longer-term EMIs. For example, if you opt for a 20-year loan your EMI falls by only 14 per cent but your interest payments increase by 39 per cent. In comparison to a 15-year loan.
3. In addition to your salary please inform the bank about your fixed income such as interest, rent, etc. so that your eligibility for the loan increases. Also, you can opt for more earning members of your family as your co-borrowers in case your loan amount required is more.
4. Make arrangements for the margin money as no bank will sanction a loan of more than 75-80 per cent of the cost of the item.
5. In the case of property the property should be in the name of the seller and the entire chain of conveyance transferred from one seller to another up to the last seller is available. The same can be got done by getting a search and title report from a lawyer.
6. The map duly approved by the respective government authority should be available.
7. A fixed ROI will always be higher than the floating ROI. In a decreasing interest rate environment, the floating rate is always beneficial. When the rates are stable than one may continue with a floating rate but can always opt for a fixed rate before the rates start increasing again which is the case at present. When rates increase try to get a beneficial fixed rate from the bank. When one opts for a floating rate one should keep checking when the bank decreases the benchmark rate so that the loan ROI is lowered by the Bank. Also in the case of housing loans in the case of say 20-year loan fixed tenure could be 10 years after which the bank may opt for a floating rate depending on the terms and conditions.
8. Generally home loans are sanctioned for 15-20 years but a study suggests that most of them are closed within 8-10 years. Ensure that there are no prepayment/foreclosure charges for your retail loans. Choose your Bank which does not charge these charges.
9. Banks usually charge processing charges for sanctioning a retail loan but there are Banks that also waive it depending on your relationship with the bank or in Festival times. So plan your loan accordingly.
10. Banks price their loan based on some benchmark rate, usually, it is the MCLR. But some banks have also started pricing their loans based on the Repo Rate (decided by the RBI in their MPC meet) which is the lowest rate. So check on both the rates and try to get the lowest rate of interest from the bank especially in today’s environment when Banks are flush with funds and liquidity is high.
11. In the case of educational loans the bank will base it on the collateral security being provided by the borrower and the interest rate on such loans will also be higher than the home loans. Usually, the loans sanctioned by public sector banks will be lower than the private sector banks. If you are going for an educational loan for a university outside India then please take care of the rate of the currency, which could be fluctuating, and increase your margin money as the Bank loan component will be fixed.
The author is the Head – Treasury, Finrex Treasury Advisors
DISCLAIMER: Views expressed are the authors' own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly